After several years of lackluster performance, Europe's largest semiconductor maker is getting its house in order. The company is narrowing its focus to fast-growing chip sectors, including sensors and car-infotainment systems, and exiting a joint venture that has hemorrhaged cash since it was created in 2009. STMicro's new target for profitability—lifting operating margins to 10% this year from minus 6.5% in 2012—is ambitious. But investors are so negative on the company now that even a near-miss could lift the stock.

STMicro's New York–listed shares (ticker: STM) fell 17% in the past three years, to $7.71. They could rise as much as 50% in the next 12 months if the company can deliver on its plan.

STMicro is expected to earn $85 million, or 12 cents a share, this year on revenue of $8.7 billion, up from a loss of 33 cents in 2012. Analysts think the company could earn as much as 59 cents in 2014.

Shares have risen 15% since STMicro disclosed its new strategic plan in December. They carry a fat dividend yield of 4.4%. The payout is backed by solid free cash flow and $1.2 billion in net cash on the company's balance sheet.

JUST FOUR YEARS AGO, STMicro and Ericsson, after much fanfare, were into the process of merging their wireless chip businesses, to gain manufacturing synergies and develop a more integrated and efficient product strategy. It didn't work out that way. The two companies pumped an estimated $1.7 billion into ST-Ericsson, which never made a profit, largely due to intense competition in the market for basic cellphones, and troubles at Nokia. Last month, the companies announced that they would terminate ST-Ericsson by the third quarter.

Peter Knox, an analyst at Société Générale, reckons investors don't fully appreciate the fact that STMicro has drawn a line under its investment in ST-Ericsson. "I think the majority of the market sees ST-Ericsson as a continuing part of the group and a burden going forward," says Knox, who rates STMicro a Buy with a $10 price target. Other analysts think the shares could go as high as $12.

STMicro is exiting the venture on favorable terms. It is taking on 950 of ST-Ericsson's 4,350 employees and getting all the businesses other than Long-Term Evolution multimode thin-modem products, which go to Ericsson. The LTE-modem business has exciting potential but requires a huge amount of research-and-development investment.

WITH ST-ERICSSON BEHIND IT, STMicro will be in a stronger position to exploit an upturn in the semiconductor market, which is widely expected this year, given an improving economic outlook. It says the markets it is targeting—sensors and power, automotive products, and embedded processing solutions like set-top boxes and TVs–will be worth $140 billion in 2013, according to the company.

STMicro generated 38% of its revenue last year from the division that produces microelectromechanical sensors such as smartphone microphones, digital compasses, and gyroscopes. With an operating profit margin of 13%, the division is STMicro's most profitable.

The Bottom Line

Now that STMicro is putting a disastrous joint venture behind it, management can focus on markets where it has an edge. Shares could rise 25% to 50% in the next year.

Its automotive unit, which accounted for 18% of revenue in 2012 and had a profit margin of more than 8%, is an industry leader in car-door electronics. It has established partnerships with car makers Audi, part of the sprawling
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11.199728874830546Market Cap
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(VOW3.Germany) group, and Hyundai Motor (005380.Korea).

With revenue spread across a variety of sectors and customers, STMicro is less vulnerable to pockets of instability. Its new strategy, focus on costs, and exit from ST-Ericsson mean it is well placed to prosper in 2013, and beyond. "These decisions will drive our growth and enable us to become stronger and much less sensitive to the market variation," says Bozotti.